Tiger traps

Asia's seemingly relentless economic rise is still not inevitable

Like most of the 30 years that preceded it, 2012 will be punctuated by statistical evidence of Asia's growing share of the global economy, and by symbols of relative Western decline. The financial crisis of 2008, followed by the various excitements of 2011—the American debt-ceiling fiasco, the euro zone's interminable wrangling, riots on the streets of Western capitals—seemed to mark a tipping-point. Asia's rise looked faster than anyone had expected.

In Asia there is some understandable Schadenfreude. After all, just over a decade ago, the region had to endure Western lectures on the failings of Asian crony capitalism. And the harsh remedies imposed on the errant Asian economies in the late 1990s now seem medicine too drastic for America and Europe. Sober Asian policy­makers, however, worry. In the short term, they know that the region would be badly hit by another severe downturn in the West. In the longer term, they wonder whether developing Asian economies will get stuck in a “middle-income trap”.

The short-term concerns may seem overblown. By September 2011 the Asian Development Bank (ADB) was still expecting that in 2012 growth in Asia outside Japan would moderate only to an annual rate of 7.5%. And, for some of the bigger economies, a slowdown is welcome. China, in particular, might actually stand to benefit. Sluggish external demand would help the government's own efforts to cool the economy and, to the extent it was reflected in low commodity prices, ease inflationary pressures too.

Vulnerability to the West's economic woes is a symptom of a longer-term worry

Yet the dangers for Asia of such a slowdown are acute. China's government will not want to risk worsening inflation by unleashing another huge stimulus into the economy, as it did in response to the 2008 crisis. And for all its efforts since then to “rebalance” the economy towards a greater reliance on domestic consumption, exports to the West remain a big part of overall demand. For the rest of developing Asia, China itself is becoming an ever more important market—the biggest trading partner for India, for South Korea and for the ten members of the Association of South-East Asian Nations taken as a block. For many countries, however, a large chunk of exports to China forms part of a global supply-chain whose end products are Western imports.

The short-term vulnerability to the West's economic woes is a symptom of a longer-term worry: a failure in many countries in Asia to progress from growth fuelled by their natural bounty and cheap labour to growth driven by higher productivity. As wages rise, manufacturers find themselves unable to compete in export markets with lower-cost producers elsewhere; yet they still find themselves behind the advanced economies in higher-value-added products. This is the middle-income trap—which saw, for example, South Africa and Brazil languish for decades in what the World Bank defines as the “middle-income” range (of about $1,000 to $12,000 gross national income per head measured in 2010 money).

Asia has the past half-century's most spectacular examples of countries that have avoided the trap: Japan, followed by Taiwan, South Korea, Singapore and Hong Kong. But for the majority of Asian countries, which are still in the “middle-income” bracket, evading the trap may not be so easy. An illuminating report produced by the ADB (“Asia 2050: Realising the Asian Century”), divides this group into two. One, led by China and India, accounts for 77% of Asia's population and 51% of its GDP, and is made up of “fast-growing, converging” economies. Another, with 18% of Asia's population and just 6% of its GDP, comprises “slow or modest growth, aspiring” economies.

Some in the second group, such as Sri Lanka and the Philippines, already, says the ADB, “exhibit the classic signs of the middle-income trap”. But even the “convergers” are vulnerable. Rising wages and other costs lay Chinese exporters open to low-cost competition in some industries from countries such as Bangladesh and Vietnam, and the competition will become more acute as China's population ages. In contrast India's boom has differed from China's and the rest of East Asia's in its reliance on domestic demand and growth in services rather than labour-intensive manufacturing. Unfortunately for Indian optimists there is as yet no precedent of a country that has broken into the ranks of advanced nations following this model.

The ADB's point is not that Asia is doomed to be caught in the trap. Rather it is that straight-line growth projections face big risks. The most obvious are of conflict in a region littered with unresolved sovereignty disputes. But the ADB also cites “recent adverse trends in the quality of institutions and rising corruption”.

The ADB report posits two Asian futures. One, “the Asian century”, assumes the boom continues more or less uninterrupted. In that scenario (see chart), by 2050 Asia will account for more than half the global economy. In a gloomier “middle-income trap” scenario, it will make up less than a third. To achieve the former outcome, Asian governments need to make difficult reforms now.